While small-cap stocks, such as China Fortune Investments (Holding) Limited (HKG:8116) with its market cap of HK$79m, are popular for their explosive growth, investors should also be aware of their balance sheet to judge whether the company can survive a downturn. Companies operating in the Consumer Retailing industry facing headwinds from current disruption, even ones that are profitable, are more likely to be higher risk. So, understanding the company’s financial health becomes crucial. Here are a few basic checks that are good enough to have a broad overview of the company’s financial strength. Though, this commentary is still very high-level, so I’d encourage you to dig deeper yourself into 8116 here.
Does 8116 produce enough cash relative to debt?
Over the past year, 8116 has ramped up its debt from HK$123m to HK$306m , which is made up of current and long term debt. With this growth in debt, 8116 currently has HK$65m remaining in cash and short-term investments for investing into the business. On top of this, 8116 has generated cash from operations of HK$25m during the same period of time, leading to an operating cash to total debt ratio of 8.0%, meaning that 8116’s operating cash is not sufficient to cover its debt. This ratio can also be interpreted as a measure of efficiency as an alternative to return on assets. In 8116’s case, it is able to generate 0.08x cash from its debt capital.
Can 8116 meet its short-term obligations with the cash in hand?
With current liabilities at HK$236m, the company has maintained a safe level of current assets to meet its obligations, with the current ratio last standing at 2.18x. Generally, for Consumer Retailing companies, this is a reasonable ratio as there’s enough of a cash buffer without holding too much capital in low return investments.
Can 8116 service its debt comfortably?
With a debt-to-equity ratio of 74%, 8116 can be considered as an above-average leveraged company. This is not unusual for small-caps as debt tends to be a cheaper and faster source of funding for some businesses. No matter how high the company’s debt, if it can easily cover the interest payments, it’s considered to be efficient with its use of excess leverage. A company generating earnings after interest and tax at least three times its net interest payments is considered financially sound. In 8116’s case, the ratio of 1.92x suggests that interest is not strongly covered, which means that debtors may be less inclined to loan the company more money, reducing its headroom for growth through debt.